Pension transfers: Despite November’s quarter percentage point increase in the Bank of England’s base interest rate, defined benefit pension scheme members are likely to continue to transfer their pension to a defined contribution pot in order to take advantage of pension freedoms. Pension schemes will need to pay particular attention to the impact that these cash outflows have on their investment portfolio to avoid an imbalance that would impact their risk or growth profile.
Peter Rowles, Head of Willis Towers Watson’s UK Retirement practice said: “We have seen a huge increase in pension transfers over the past few years, since pension freedoms came into force. Members are looking at the transfer value quote they are able to obtain from their scheme, along with the opportunity often to take a bigger tax free lump sum from a defined contribution pot, and a large number are choosing to transfer out of their DB scheme.
It could be argued that with interest rates rising and gilt yields improving, schemes will start to see a reduction in their liability figures which could correspondingly lead to lower transfer values being offered to members, reducing the temptation for individuals to transfer out of a secure DB pension. But the indications are that interest rates, although rising, will do so slowly and I think this is unlikely to have an immediate impact on transfers in 2018 – we are going to continue seeing significant numbers of employees exiting their defined benefit pensions this year.
Clearly this kind of decision shouldn’t be taken lightly. As we enter an era of higher inflation, an index linked DB pension can provide the kind of long-term security that isn’t necessarily available to those with a flexible DC retirement pot. People should also seek independent financial advice before making any big decisions on their financial future.”
Master trust regulation: New regulation will also play a significant role for pensions in 2018. In particular the tighter legislative control of the master trust market being brought in by the Department for Work and Pensions will lead to large scale consolidation of providers.
Rowles commented: The regulatory framework for master trusts, announced by the DWP in December, will bring a welcome focus on governance and member outcomes from all providers who apply for authorisation to continue operating. Master trusts are becoming a more and more significant part of the pensions market and employers and employees need to feel confident that very high standards of governance are being adhered to consistently by all providers, and there is regulatory oversight by the government.
We anticipate that the introduction of these new regulations will lead to a consolidation in the number of operating master trust providers from the current level of around 70, to approximately 20 providers within a year. This will create a competitive industry of credible providers which will be better placed to serve the interests of both employers and employees.”
Other legislative changes: Rowles continued: Although the shadow of large scale reform of the pension tax relief system will continue to be front of mind in the run up to the Chancellor’s Spring Statement and Autumn Budget, it’s unlikely the Parliamentary mathematics will enable the government to push through significant changes in this area next year. That doesn’t rule out more peripheral changes that are easier to enact, such as changes to the Annual Allowance and Lifetime Allowance thresholds.
The government is due to publish a White Paper on defined benefit pensions in 2018 and it will be interesting to see how radical it is, given the twin challenges of Brexit and Parliamentary support. Either way, Trustees and employers will face the challenge of navigating a potentially tougher Regulator in a low growth environment, where employers will naturally look to conserve cash. The challenges of linking good governance with good outcomes for members will prompt many companies sponsoring a DB or DC scheme to ask: ‘Is there a better way?’
Pension contributions:Rising pension contributions will dent take-home pay, without leading to large-scale opt-outs. The minimum amount that people will save into workplace pensions by default will increase in April.
Rowles said: Not everyone will be affected by this – many large employers provide pension schemes which already pass the new, more demanding, quality tests with flying colours. Someone on a salary of £25,000 who is affected will typically see take-home pay fall by around £17 a month after taking account of tax, National Insurance and pension changes, unless they get a pay rise at the same time – though the precise numbers depend on which set of rules the employer has chosen to follow.
Real wages are much lower than they were expected to be when this policy was first devised and some employees who are really feeling the pinch may choose to stop saving. However, this should not be too common: the low opt-out rates we have seen so far demonstrate that inertia is a powerful force, that people recognise they need to provide for their retirement, and that handing back an employer contribution does not feel like a sensible thing to do.
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